Credit Spread vs Debit Spread—Which is Better?

Credit Spread vs Debit Spread: Are you wondering which is better: option trades that result in a credit or trades that result in a debit?  Simply put, you’re asking whether you should choose a credit spread strategy or debit spread strategy.  Let’s consider both options in more detail. 

Explaining Credit Spreads

A credit spread (also called a net credit spread) involves the investor selling one option then buying another option.  The second option is in the same class and also shares the same expiry date.  However, there are different strike prices between the two options.  In this instance, the new investor gets a net credit for entering this position.  He is looking forward to the spreads either narrowing or expiring in order to get a profit.  A credit spread is basically a conservative strategy in investment.  It is designed to earn a moderate level of income while also limiting your potential loss.  In this circumstance, you are buying and selling options on the same index in the same month.  Remember, the only thing different is the strike price.  The most common credit spreads are the Bull Put Spread and the Bear Call Spread.

Credit Spreads

What about debit spreads?  First of all, investors have to pay to enter a debit spread (or net debit spread).  This option is when the investor buys an option with a higher premium but must sell the option for a lower premium.  How will this bring profit?  Because the investor is hoping that the premium of his two options will widen due to the market.

Options Selling Strategy

Another issue to consider is that of what type of strategy you are going for with credit or debit spreads; as in bull or bear?  The bull or bear strategy involves doing what you’re doing—selecting selling two options, but choosing both call or put options, and with the same expiration dates.  (The strike prices can be different)  The basic philosophy of bullish in stocks is that you buy low and sell high, which can be called an optimistic outlook, or bearish, buy high and sell low, which is a pessimistic approach.  Both of these may work with any given strategy.

When you bring credit/debit into the equation, there are more issues to resolve.  First know that with a credit spread, the required margin will be the same as the difference between both strike prices.  This is the most you can lose.  Your capital requirement will be reduced since you can apply the credit of premium to the margin.  Now let’s consider debit spreads on the opposite end of the spectrum.  These are called debit spreads because your broker is actually going to debit your account for the net premium, as opposed to giving you credit.  The most you lose with the debit spread is the premium net.  Gains are limited and this option does not require a margin.

The Deciding Factor

In deciding which works better for you consider the time value involved.  If you know a stock or underlying is going to move in a certain direction and you know to what price a debit spread can result in more profit. On the other hand, if all you know is a stock is going to move in one direction or not much, than you can place your trade in the other direction.

Let’s look at an example. If you use technical analysis, you can determine support and resistance lines, as well as trendlines. Say a stock is trending up and has support at $50 and is trading at $54.39 right now.

You feel the stock is going to go higher but you do not know by when. Your best bet is to sell a 50/45 Put spread. You sell the 50 put and buy the 45 put in the same month. For the sake of the example, you will trade the current month with the fewest days to expiration. As long as this stock stays above $50 you make the full amount of the credit.

If you think the stock is going to go to $60 in 2 weeks, you can use a debit spread. You would buy the 55 call and sell the 60 call in the same month. You would get the max profit if the stock is above $60 at expiration. But if the stock does not move up, your options will lose value everyday and eventually expire worthless.

With a credit spread, if the stock does not move, you still make money.

Basically we are talking about two sides of the same coin. A debit spread for one  option trader is a credit spread for another.

9 Comments

  1. Xueren Zhang on November 7, 2009 at 11:23 am

    But according to some statistics,around 88% of options expires worthless.Therefore,for practical reason,debit call and put spreads ,even though they have advantages,still a hard game to play,unless we have at least 80% chance that the underlying security will go up or down to a certain range.Credit spread,on the other hand,may be “safer”,if we are 80% sure of strong support and resistance level.Selling put spreads with some “dead” blue chips like MCD,KO,VZ,PG are my trades since March,for income purposes.Every month,there is a selling opportunity with one of those stocks.Trendy stocks like FCX,AAPL,GS are also worth to get into,but big price swings often make me nourvous.Everytime, dropping 10 to 25 points is good time to enter selling put spreads.It is same as buying stocks at dip,if we have enough capital.Iron condors are better choices,because they are involving selling both call and put spread.OG is a fine craftsman to design SPX and RUT.I would also love him to recommend,once in a while, an iron condor to take a stock ( of course,more complicated than index ).

  2. Joe B on March 17, 2010 at 11:57 pm

    What about buying in-the-money debit spreads? In this case, the underlying can stay where it is, go up, or down, and you can still profit from the difference in time value of the 2 strikes. The underlying just has to stay above the sold strike (in the case of calls) for maximum profit. I haven’t tried this yet ‘for real’ but I’ve been paper trading it, and wonder if you have any advice.
    One disadvantage is that you have to buy back the position at expiration and can get burned by the bid-ask spreads, and commissions.
    I would love to know anyone’s thoughts or experience with this strategy! Thanks.

  3. MIKE LOOS on June 29, 2010 at 8:39 am

    the ITM Debit Spreads seem to have the lowest theta or time decay i think, but the premiums are much higher too.
    I feel that for me a Credit spread has a better chance of
    success less risk and less profit but more winners and
    less of a draw down on your margin account. Allen, does
    this reply sound right to you? Michael

  4. Tom Nunamaker on April 9, 2011 at 1:58 am

    Any vertical spread with a short option ITM is at risk of assignment. It doesn’t matter if it’s a debit or credit. If you have a vertical spread in this situation, keep an eye on the time premium. If it gets under $0.10 or $0.15, I’d either close the position, roll the short option or box the position off to a riskless position… unless you want to be assigned.

    ITM options are more expensive and have bigger bid/ask spreads and are often not as liquid as ATM options. You can get burned trying to get out of an ITM option with slippage.

    To avoid the exercise and expensive ITM options, most people trade OTM credit spreads.

  5. Steve Johnson on April 18, 2011 at 9:57 am

    The better of the two would be a credit spread for me –
    the percentage is on your side – can profit in a sideways makt. as well. If one knows how high a stock might move, then a debit spread could be the choice. However, either one is a gamble. It seems knowing the volatility on either position in advance is necessary before choosing to invest.

  6. Jeff on May 29, 2011 at 4:20 pm

    I agree, in part. If one “knew” how high a stock would move, then the natural play would be sell naked. But, since nobody does know, the obvious smart strategy is Credit spreads, with potential for morphing into Iron Condors for additional profit.

  7. kamlesh on February 6, 2012 at 12:01 am

    i think if u r technically sound dhen, better to do debit spread with the trend and do credit spread on the opposite side of the trend.if u go wrong in judging the trend do adjustment in credit spread in double quantity.

  8. Keith Harrison on April 6, 2012 at 6:41 pm

    This is all a bit difficult to take in, folks. A couple of examples of various kind of spreads, their percentage of risk, the amount of margin needed and the possibilities for profit and loss would be VERY useful, as it all seems a bit abstract, especially for those, like me, who are relatively new to these complexities. Could anyone give some recent examples of successful trades on credit or debit spreads and the risks they took. That would help a lot.
    Thanks.

  9. Tracy Naegele on September 30, 2014 at 9:01 pm

    Howdy! Would you mind if I share your blog with my twitter group? There’s a lot of folks that I think would really appreciate your content. Please let me know. Many thanks

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